Thursday, December 30, 2010

From Linguistics to Economics: More of Mexico and China

Economists Timothy Kehoe of the University of Minnesota and Kim Ruhl of New York University explore in a paper (PDF) just how difficult it is for a country to leap from what the World Bank calls “middle income” status to the ranks of advanced nations. South Korea and Singapore are nearly alone in having made that transition. Most every other poor nation–whether one calls them “third world,” “developing” or “emerging”–gets stuck in second-tier, Mexican-style status.

“Absent continuing reforms,” the economists argue, “Chinese growth is likely to slow down sharply, perhaps leaving China at a level less than Mexico’s” — an outcome that would be a hard slap to the China-as-future crowd.

While Mexico and China seem very different, the economists point out a number of similarities. On the positive side, the two nations focused on foreign trade as a growth engine and they eased central government control of the economy. On the negative side, their financial systems are inefficient, their non-tradable industries (communications, transportation and the like) lack competition; and their rigid labor rules discourage employers from adding full-time workers.

The economists argue that despite the handicaps, developing nations can make big leaps in growth as they catch up with countries like the U.S. Mexico made its big leap forward in growth from 1953 to 1981; China has been making its move since around 1980. Mexico’s GDP per-capita is now about twice China’s, according to the International Monetary Fund.

Once that catch-up period is over, however, the countries need to continue to reform institutions and policies to produce a well-functioning government an efficient financial system and a steady increase in knowledge so it can continue to grow smartly. Few countries manage that transition, which leaves them well behind the U.S. and Europe.

This also doubles as a reminder that for all the justified excitement over China's economic performance over the past three decades or so, it still remains a poor nation.